Contract breaching in agricultural markets: An experiment on double moral hazard

Contract farming is increasingly used to coordinate transactions between farmers and buyers downstream in food chains. However, the potential gains of contracts are often undermined by contract breaches from both buyers and sellers. In this paper we develop a simple buyer-seller contract model where we introduce the option of buyers to choose whether or not to offer a binding price to sellers. We assume agents are rational and self-interested, and that in single or double moral hazard settings there should not be differences in profits between buyers and sellers. We test our model in a laboratory experiment where we vary whether: (i) only the seller can renege on the initial agreement (single moral hazard), (ii) both the buyer and the seller can renege (double moral hazard), (iii) buyers can choose whether they are bound by their initial contract offer or not when the contract is determined. In contrast to theoretical predictions, we find that the single moral hazard setting is Pareto superior to the double moral hazard one, as it increases total profits and reduces income inequality. In the third treatment, we find that buyers opt to retain the right to renege on the initial contract offer and use it as a substitute for a lower price offer.